Trading with CFDs

Since its value is derived from the value of these assets, the CFD is a “derivative”. CFDs do not include financial paperwork, are fast and especially simple to administer. All of this contributes to its growing popularity. All transactions are purely contractual and there is no physical delivery of any product.

How do CFDs work?

CFDs are over-the-counter products, which means they are not listed on any exchange. Instead, traders and investors trade directly with each other, although neither of them has ownership of the asset.

Similarly, the investor predicts whether the value of an asset will rise or fall in a given period, and the CFD provider accepts the “variation” for an agreed value. You trade on the value of the price difference between the opening and closing point in the given period.

What separates CFDs from a normal share purchase, for example, is that you don’t pay the full price upfront. Instead, you only need to have between 1% and 5% of the transaction price available in your account. The rest of the amount is “borrowed” by the CFD firm.

“Borrowed” capital frees the investor to speculate in a much wider range of underlying assets than would otherwise be possible. The amount that a company can make available is normally proportional to the amount you have deposited in your trading account.

Basic CFD Terminology

To better understand CFDs before adding them to your portfolio, you should learn some basic terms that are frequently used:

• Buy position – This is when you buy an asset expecting that its value will increase during the contract period. In English, they are known as “long positions”, as they are normally maintained for longer periods: from 1 month to more than 1 year.
• Selling position – Naturally, the selling position is the opposite of the buying position; Here, the investor anticipates that the value of the underlying asset will fall. They are known in English as “short positions” and can be used in the same asset in which the investor maintains a purchase position, allowing him to profit from short-term declines. Trades in sell positions can be held for periods as short as one minute.
• Underlying Assets – The price of a CFD obtained from and intrinsically linked to a physical market asset.
• Exposure – Indicates the real value of your trade, regardless of the amount you have available in your trading account. For example, if your trading firm offers a CFD worth $5,000 for 5% of its total value (i.e. just $250), your exposure remains $5,000 and you are responsible for the full amount.
• Spread – Not all trading firms charge commissions: they earn through the difference between the actual value of an underlying asset and the value offered to clients. For example, a buy position on a stock CFD whose current value is $10 may be offered at $10.20. This means that its value must exceed $10.20 for the customer to profit.

Leverage and margin in CFD trading

Much of the appeal of CFDs is that they require a low cost of capital compared to their real value (exposure). They allow smaller investors to trade an underlying asset that would normally be out of their reach. This is known as leverage or margin trading.

A typical stock and bond trading account typically provides investors with 2:1 leverage, meaning you need to have 50% of the exposure value in your trading account. In contrast, a CFD trading account provides leverage of around 20:1, which is just 5% of the total exposure value.

For example, if you have a stock and bond trading account with a traditional brokerage and want to buy 1,000 shares of a $10 stock, you would have to have at least $5,000 (50% of 1,000 x 10) . Now, if you buy 1,000 contracts of a $10 CFD from a typical CFD trading firm, you will only need to have $500 (5% of 1,000 x 10).

So even though the exposure (and your liability) is $10,000 in both cases, you can get into CFD positions with much less. You will be entitled to your profit or suffer your loss as if you had purchased your position 100% upfront.

If the investment does not work out in your favor, the trading firm will contact you to make up the difference. This is known as a “margin call”. It indicates the amount you need to deposit into your account to sustain your losses.

Advantages and disadvantages

Like any other product in your portfolio, there are advantages and disadvantages to CFDs. Understanding them will allow you to make better decisions before entering the market.

Advantages of CFDs

• Range – The ability to trade high underlying assets with a small deposit.
• Cost – There are normally no commissions charged on CFD transactions.
• Speed – A CFD contract is activated immediately when you accept the quote from the trading firm.
• Accessibility – CFDs are available 24 hours a day on online platforms such as psi-markets.

Disadvantages of CFDs

• Risk – The reduced cost may tempt investors to take unnecessary risks.
• Participation – Investing in shares through CFDs excludes typical rights of a shareholder, such as participation in management meetings.
• Cost – Some CFDs include holding costs at the end of each trading day.

psi-markets USP

psi-markets is an online trading platform that allows you to trade CFDs on underlying assets from anywhere in the world. Our low fees and charges, as well as our tight spreads, open up the opportunity for you to trade with a competitive broker.